Long Term Capital Gain cannot be treated as bogus merely on the basis of suspicion that SEBI had initiated some action or investigation

Brief facts:

• The assessee is the proprietor of M/s A.K. Exports (hereinafter ‘AKE’) who is engaged in the business of trading of gold jewellery and bullion through his business unit.
• The AO made additions towards long term capital gains derived from sale of shares and claimed as exempt u/s 10(38) of the Act, to the tune of Rs. 16.24 crores for the reason that the gains computed from sale of shares were unrealistic and the scrip was rigged in the market to derive undue benefit to the assessee.
• The fact with regard to the impugned dispute are that the assessee has acquired 6 Lakhs equity shares of M/s Indo American Advanced Pharmaceutical [subsequently name changed to Mahavir Advanced Remedies Limited] at Rs. 11 per share in a private placement and paid consideration of Rs. 66 Lakhs through banking channel. The shares were later converted into demat form and sold in AY 2015-16 on which the assessee claimed exempt LTCG Rs. 16,24,68,072/- u/s 10(38) of the Act.
• The AO was of the opinion that the Directorate of Investigation, Kolkata carried out a country-wide investigation to unearth the organized racket of generating bogus entries of LTCG which is exempt from tax. According to the AO, the hike is share price of the company is unrealistic and that the assessee has earned 2613% of returns on investment when compared to sensex. Even the financials of M/s Mahavir Advanced Remedies Limited are weak but the share prices in stock exchange was skyrocketed. The AO has taken support from the trading details verified by SEBI on BSE exchange. Therefore, he was of the opinion that LTCG derived by the assessee is nothing but unexplained credit and accordingly made additions towards LTCG to the taxable income.
• The assessee preferred an appeal on various other issues including this issue before CIT(A). The assessee challenged additions made towards LTCG derived from sale of shares on the ground that although the AO has alleged that the assessee is beneficiary of bogus long term capital gain derived from sale of penny stocks but failed to link the transactions of the assessee with any alleged scam related to bogus LTCG. The Ld. CIT(A) however was not convinced with the explanation of the assessee.
• The Ld. CIT(A) had discussed the issue in light of various judicial precedents including the decision of Hon’ble SC in the case of Mcdowells reported in 154 ITR 148 to arrive to a conclusion that the assessee had adapted a colorable device to avoid tax payable to the exchequer by way of bogus LTCG. Accordingly, sustained additions made by the AO by holding that the transactions between the assessee and the company were mere accommodation entries to benefit the assessee by claiming exemption u/s 10(38). Being aggrieved, the assessee preferred further appeal with Tribunal.

Submission by the assessee:

• The AO has never linked transactions of the assessee to any scam related to bogus LTCG, as alleged in the light of the investigation carried out by the Directorate of Investigation, Kolkata.
• The Ld. CIT(A) has failed to appreciate that all the conditions required for claiming exemption u/s 10(38) of the Act, had been met by the assessee. The AO has made addition based on the theory of preponderance of probability, purely on guess work, conjectures and surmises, but the findings recorded by the AO is neither supported by any evidence collected during the course of investigation by the Directorate of Investigation, Kolkata nor the details collected during the course of investigation was provided to the assessee for his comments.
• The AR further submitted that the assessee is a genuine investor in shares and securities, purchased the shares by making payment through proper banking channels through recognized stock exchange and the said shares had been sold through demat account. Therefore, exemption u/s 10(38) of the Act cannot be denied on mere suspicion in the absence of any proof.

Cases relied upon by the AR:

1. Vidhi Malhotra vs. ITO- 101 Taxmann.com 361 (ITAT-Delhi): Purchase of shares is not doubted by AO because AO while adding the LTCG has given the benefit of price paid for acquisition of shares. Shares were also purchased through account payee cheque duly reflected in the books and shown by the assessee in the earlier years. Mere statements of directors of company involved in rigging cannot be the sole ground to implicate assessee and justify the additions especially when, nowhere the assessee has been found to be beneficiary of any kind of accommodation entry in any enquiry by the investigation wing or any such material has been unearthed by the department.

2. Vipul Patel Vs. ITO- 110 Taxmann.com 215 (ITAT- Kolkata): The fact of holding the shares in Demat account cannot be disputed. Further the AO has not even disputed the existence of the Demat account and shares credited in Demat account of the assessee. Therefore, once, the holding of shares in demat account cannot be disputed, then the transaction cannot be held as bogus. The AO has not disputed the sale of shares from the demat account and the sale consideration was directly credited to the bank account of the assessee, therefore, once the assessee produced all relevant evidence to substantiate the transaction of purchase, dematerialization and sale, then, the same cannot be held as bogus transaction merely on the basis of report of Investigation wing wherein there is a general statement of providing bogus LTCG transaction to the clients without stating anything about the transaction of allotment of shares by the company to the assessee.

3. Meghraj Singh Shekhawat Vs. DCIT- 103 Taxmann.com 374 (ITAT Jaipur): The holding of the shares by the assessee cannot be doubted and the finding of the AO is based merely on the suspicion and surmises without any cogent material to show that the assessee has introduced his unaccounted income in the shape of long-term capital gain.

4. Navneet Agarwal Vs. ITO- 97 Taxmann.com 76 (ITAT Kolkata): It is well settled that evidence collected from third parties cannot be used against an assessee unless this evidence is put before him and he is given an opportunity to controvert this evidence. The evidence based on which the DDIT report is prepared is not brought on record by the AO nor is it put before the assessee. Just the modus operandi, generalization, preponderance of human probabilities cannot be the only basis for rejecting the claim of the assessee.

5. Pratik Suryakant Shah Vs. ITO- 77 Taxmann.com 260 (ITAT- Ahmedabad)

6. Ramprasad Agarwal Vs. ITO- 100 Taxmann.com 172 (ITAT- Mumbai)

7. Karuna Garg Vs. ITO- 109 Taxmann.com 403 (ITAT- Delhi): There is no dispute that the statements which were replied by the AO were not recorded by the AO in the assessment proceedings but they were pre-existing statements recorded by the Investigation Wing and the same cannot be the sole basis of assessment without conducting proper enquiry and examination during the assessment proceedings. Neither the AO conducted any enquiry nor has brought any clinching evidences to disapprove the evidences produced by the assessee.

8. Smt. Madhu Killa Vs. ACIT- 100 Taxmann.com 264 (ITAT Kolkata)

9. CIT Vs. Arun Kumar Agarwal (HUF) 26 Taxmann.com 113 (Jharkhand HC): We are of the considered opinion that the Ld. AO was much influenced by the enquiry report which may have been brought on record by the efforts of the AO and that enquiry report was prepared by SEBI and from the observations made by the AO himself, it is clear that after getting that enquiry report, the SEBI prima facie found involvement of some of the share brokers in unfair trade practices. Even in a case where the share broker was found involved in unfair trade practice and was involved in lowering and rising of the share price, and any person, who himself is not involved in that type of transaction, if purchased the share from that broker innocently and bonafidely and if he shows his bonafide in transaction by showing relevant material, facts and circumstances and documents, then merely on the basis of the reason that share broker was involved in dealing in the share of a particular company in collusion with others or in the manner of unfair trade practices against the norms of SEBI and stock exchange, then merely because of that fact a person who bonafidely entered into share transaction of that company through such broker then only by mere assumption such transactions cannot be held to be a sham transaction.

10.  ITO Vs. Aarti Mittal- 149 ITD 0728 (ITAT Hyderabad) It is found that the AO has not brought out any material to establish the final outcome of the enquiry initiated by SEBI and specific shares purchased by the assessee in course of making investment. Therefore, it is not possible to take any adverse view on the basis of mere suspicion that SEBI has initiated some action and found the brokers violating the SEBI rules.

11. Farrah Marker vs. ITO- ITA No. 380 11/2011 (ITAT Mumbai): We are of the considered opinion that the AO/ CIT(A) have made the addition u/s 68 merely on presumptions, suspicions and surmises in respect of penny stocks; disregarding the direct evidences placed on record and furnished by the assessee in the form of brokers contract notes for purchases and sales of the said shares, copies of the physical share certificates and demat account statement establishing the holding of shares in her name prior to sale thereof, receipt of sale proceeds through banking channels etc. The statement of any other person would have no evidentiary or corroborative value as it was recorded behind the assessee’ back and also since the assessee was not afforded opportunity for rebuttal of the same and to cross-examine the said person.

12. CIT Vs. Sumitra Devi- 268 CTR 0351 (Rajasthan HC): Several suspicious circumstances were indicated by the AO but then, findings as ultimately recorded by him had been based more on presumptions rather than on cogent proof. The AO had failed to show that material documents placed on record by the assessee like broker’s note, contract note, relevant extract of cash book, copies of share certificates, demat statement etc. were false, fabricated or fictitious. The appellate authorities have rightly observed that the facts as noticed by AO, like the notice u/s 133(6) to the company having been returned unserved, delayed payment to the brokers, and dematerialization of shares just before the sale would lead to suspicion and call for detailed verification but then, for these facts alone, the transaction could not be rejected altogether, particularly in absence of any cogent evidence to the contrary.

13. Nirav Kumar Mahendra Kumar Sapani Vs. DCIT- ITA No. 2033/2017

Submission by DR:

• The Ld. Senior standing counsel for the department supported the order of CIT(A) based on the findings of investigation report. He submitted that there is no error in the findings recorded by the Ld. AO and Ld. CIT(A) to disallow the exemption claim u/s 10(38) of the Act.
• He relied upon plethora of judicial precedents including the decision of Hon’ble Madras HC in Tax Appeal No. 198 of 2019 and the decision of Hon’ble SC in the case of Suman Poddar Vs. ITO reported in [2019] 112 Taxmann.com 330.

Observation of ITAT:

• The AO gone on the basis of the theory of human probabilities or preponderance of probabilities without reference to any material then it is difficult to accept the reason given by the AO to hold that the transactions of long-term capital gain is bogus.
• We find that all allegations made by the AO was successfully countered by the assessee with necessary evidence. Although the AO has stated that the assessee is not a regular investor in shares and stocks, but evidences filed before us clearly indicate that the assessee is a regular investor in shares. The said investments has been disclosed in the schedule of loans and advances in the Balance Sheet for the year ended 31-03-2013.
• The AO has also made another allegation that investigation carried out by the Directorate of Investigation, Kolkata had brought out a list of 87 companies involved in bogus LTCG. The AO neither furnished the list of 87 companies in the assessment proceedings and it is not shown in, under which serial number this company appears in the said list. The name of the company in which the assessee invested also don’t find a place in the list.
• The AO and CIT(A) has referred to number of cases wherein the denial of exemption had been upheld by the Tribunal/ High courts. In all those cases, the shares had been acquired by giving cash for acquiring the shares. Here is a case where the acquisition of shares was through banking channels and it is not disputed by the Department.
• There is no broker whose statements has been put against the assessee. Again, the investigations were in respect of Kolkata companies and not in respect of this particular company.
• The AO totally ignored the genuine documents produced before him and passed the assessment order on a sweeping statement without any material evidence or fact on the record.
• It is very clear that the observations of the AO in his assessment order on the basis of report of investigation wing, Kolkata is a general observation of modus operandi of certain brokers who are involved in alleged scam of LTCG, but it cannot be a conclusive evidence to draw an adverse inference against the assessee of having benefitted from so called alleged scam. Suspicion, howsoever strong, cannot take place of evidence as held by the Hon’ble SC in the case of Umacharan Shaw & Bros Vs. CIT (1959) 37 ITR 271 (SC).
• This view is fortified by the decision of Hon’ble SC in the case of Omar Salay Mohamed Sait Vs. CIT (1959) 37 ITR 151 (SC) where it was held that no addition can be made on the basis of suspicion and conjectures.
• All these transactions are properly through proper banking channels, dematted and subject to securities transaction tax. When the pre-requisite conditions imposed by the legislature stands complied in toto, the AO cannot proceed to treat the same as bogus and disallow the same solely based on the fact that the shares prices went up substantially.

Conclusion: We are of the considered view that the AO as well as CIT(A) were erred in holding that LTCG derived from equity shares is bogus in nature. Hence, we direct the AO to delete additions made towards Long Term Capital Gain derived from transfer of shares.

Also Refer:- PCIT (Central)- 3 vs. Anand Kumar Jain (HUF) Delhi HC